i know ALM is used when a person or company had definable liabilities, and ALM helps match the duration of portfolio assets and liabilities. What’s confusing is surplus ALM which try’s to maximize the surplus btw assets and liabilities. How are you maximizing surplus but matching duration at same time??
asset after X ( let say 10yr, industry standard) year will be at a certain level and liabilities will be at Y level.
X-Y is your surplus after the 10 yrs, you test multiple (1000) 10yr economic scenario under 1 portfolio. you check the average surplus and the volatility of surplus for that given portfolio over the 1000 final value.
you change the portfolio, you re-do the 1000 economic scenario with that portfolio, you check the average surplus and the volatility of surplus for that given portfolio.
continue thos step until you have tested a good amount of portfolio.
now each portfolio will have his own expected surplus and volatility of surplus, you chose the one that maximise the surplus for a giving volatility of surplus.
you now have a efficient frontier. based on average surplus and volatility of surplus
Maybe I’m confusing matching duration and return. Just because you match duration of a portfolio and liabilities doesn’t mean you can’t earn a return that increases the difference in assets and liabilities, correct?
I guess after reading the fixed income section, I tended to think of ALM as only using fixed income securities but that’s not the case? You just want to match the duration of the liability but that can be done with a combination of assets?? In the process too, you can also earn a higher return inove what’s needed to meet liabilities?
Asset can be anything you want. the ALM process is comparing a giving asset portfolio evolution at the same time as the liability evolution for a giving scenario. so once you know how both react to economic changes, you can allign them ( allign them perfectly, not perfectly, not at all… as u wish )
even if they are very very far from each other, and you do scenario analysis incorporating both assets and liability, well you are doing a ALS ( asset liability study )
when you are incorporating both measure, it is much more easier to allign your portfolio with your liability.
ALM is Asset liability Management, not asset liability matching
Asset/liability management (ALM) approach In the context of determining a strategic asset allocation, an asset/liability management approach involves explicitly modeling liabilities and adopting the allocation of assets that is optimal in relationship to funding liabilities.
Institute, CFA. Level III 2013 Volume 4 Fixed Income and Equity Portfolio Management. John Wiley & Sons P&T, 6/18/2012. .